529 Plan FAQs

Cameron Huddleston, Contributing Editor, Kiplinger.com,  Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
Friday, February 22, 2008; 8:12 AM

Since Kiplinger's first wrote about tax law changes concerning state-sponsored college-savings plans in 2001, readers have asked quite a few questions about how to pick the best plan, how to choose between a Coverdell Education Savings Account and a 529 plan and how to enroll.

Is a state 529 plan the way to go?

When the first Bush tax law took e ffect in 2002, state-sponsored college savings plans -- otherwise known as 529 plans -- became the hands-down best choice for your c ollege dollars.

Withdrawals for qualifying education expenses are tax-free. This tax-free status was set to expire in 2010, b ut Congress made the benefit permanent in 2006. Also, 529 plans are treated as parental assets when it comes to financial aid. (Pare nts are expected to kick in just 5.6% of their assets while students are expected to contribute 20%.)

Here are other reasons to consider a 529 plan:

  • They're simple. State 529 plans are easy. Choose an investment option and make contribu tions and the plan does the rest. Sit back while the state or a third party, such as an investment firm, manages your funds.

  • Contributions may be state-tax deductible. Thirty-one s tates and the District of Columbia allow you to deduct some or all of your contributions. Rules vary, so check with your state f or more details.

  • They're portable. Depending on the state, you can choose from a number of different inv esting options. You also can switch investment tracks within the plan once a year. And if you don't like your state's plan, shop aro und. Plans are open to residents and nonresidents alike. You also can roll your savings into another state's plan without penalty.
  • There are no set annual contribution or income limits. Contribution limits vary by state, and some states do not limit contributions at all -- a good option for grandparents looking to transfer assets through estate planning.

Don't think of Coverdell ESAs and Section 529 plans as mutually exclusive. If you have the money, consider funding both. ESAs al so can be spent on private school tuition or other qualified educational expenses.

Which state has the best plan?

If you live in one of the 31 states and District of Columbia that offer a deductible contribution, there's proba bly no need to look further. Your savings on taxes likely will overcome any shortcomings your state's 529 plan might have.

If you don't get a deduction, then consider these top picks:

What makes these state plans so good? Low expenses and plenty of inv esting options, two things you should focus on when making your choice.

Expenses. Annual fees, as well as management a nd maintenance expenses, can eat into returns and can vary greatly from state to state. If you choose to open your account through a broker, versus directly through the state, these fees and charges may be even higher. Also keep in mind that nonresidents typically pay higher fees than residents.

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